HOA Loan Rates and How They Correlate with Bond Yields

by | Condominium Financing, HOA Financing, HOA Loan, Loans, Understanding Financing

Bonds Correlate with HOA Loans

For a very long time, the prices of Treasury bonds have been increasing. The interest rates associated with short-term bonds, in particular, have declined to levels not seen in about a decade. By definition, rising bond prices lead to lower yields or returns.

Why does this matter to an HOA Board?

Because bond yields correlate with the interest rates on HOA loans.

Most Boards have seen firsthand that lower bond yields have translated into lower returns on reserve accounts. Lower returns impede the growth of reserve accounts. However, pain for one HOA can be an opportunity for another association.

Rising bond prices have created a Goldilocks scenario for HOA loans. Most HOA loans are structured with an interest rate that is constant for the life of the loan. When HOA boards decide to borrow funds, they are effectively locking in their borrowing costs for the life of the loan. With interest rates low, as they have been for some time, the costs associated with borrowing money are attractive. In other words, when we are in a low-interest-rate environment, it can be an appealing time to incur debt.

Unfortunately, the Federal Reserve Chair has indicated a near-term change in policy. Over the past few months, the rate of inflation has been high. Higher inflationary pressures prompted Mr. Powell to set expectations for a series of interest rate increases in the coming months.

Think of interest rate movements like ripples that a rock makes when tossed into a calm body of water. The waves nearest the rock’s entry point or center move quickly while the waves further out cover greater distances. The rates on short-term bonds simulate the entry point of a rock. They usually move quickly. But the longer-term interest rates are more like the ripples that are further from the center. They tend to cover a greater distance. When Mr. Powell begins implementing policy changes, interest rates will move. These changes will be akin to the Federal Reserve tossing a few rocks into the lake.

If Mr. Powell’s comments are supported by an earnest policy change, interest rates will begin to increase sometime in the near future.

This scenario presents an opportunity for borrowers, especially those who need longer-term money. While HOAs can still achieve reasonably low-interest rates, this window may not be open for long. Many economists feel long-term interest rates have bottomed out for the foreseeable future. If they are correct, the longer-term consequences will be unfortunate news for future borrowers.

Why should HOAs care about what’s happening in the bond markets?

Some HOAs have ample reserves to handle any repairs that come their way. Others can assess owners. However, many HOAs will need to borrow funds when the need arises. If your HOA is on the borrowing side of the equation, you should care. Given how much interest rates have been moving lately and the forecast for future rate increases, you should care a great deal.

If your HOA has been putting off a major repair or improvement, it may be time to re-examine your approach. Consider a scenario where your HOA needs to borrow $1 million and is budgeting for a 10-year loan with a 5% interest rate. The total interest that your association will pay is around $270k over the 10-years. However, if your loan’s interest rate ended up being 6% (an increase of just 1%), your HOA’s total interest payments would be closer to $330 thousand. In this example, a 1% increase in an interest rate would raise your total borrowing cost by more than $60
thousand or over 20%.

Interest rates are still low by historical standards. If your HOA is considering taking out a loan, it may be time to test the market. It’s better to be in front of an interest rate increase than chasing an interest rate once the market has changed.

Arch Capital Solutions acts as an advocate for your HOA. We have relationships with lenders who specialize in HOA loans.

In many states, the board may have a fiduciary duty to make financial decisions that are in the best interest of its members. Arch Capital Solutions can satisfy those fiduciary duties acting as the HOA’s financial advisor. We help HOAs obtain financing and choose the best proposal from multiple lenders.